The gravity equation in international trade - Myassignmenthelp.Com

Question: Discuss aboutThe gravity equation in international trade. Answer: Introduction The report applies Gravity Model for the purpose of analyzing bilateral trade of other countries and Vietnam of 2015. The model is a popular econometric model in international trade. The model came from its use of gravitational force concept as a method of explaining volume of joint trade flows between different countries. In my report I embark on the use of data on international trade of Vietnam and other countries. The approximate results revel that distance and culture, economic size of foreign partners, the economic size of Vietnam largely affected bilateral trade flows between other countries and Vietnam. The report also included the use of varied variables, assumptions of their influences to Vietnam as a country, difficulties of gravity equations and their actual resolving. Gravity model is a practical success because it precisely foretells trade flows of Vietnam and other countries for many goods and services. Nevertheless, gravity correlation can ascend in nearly all the trad e model and it consists of trade costs which arise as the distance increases. The question always arises in regard of what factors influences the selection of foreign trade partners of Vietnam for the purposes of exploiting the comparative importance of each country. Gross Domestic Product (GDP), geographical distance, the actual population greatly influence trade flows between different countries like Singapore and Montanari. The first section states the literature review on the model and the advantages on the international trade. The second part describes and illustrates the actual meaning of gravity model and the definition of various variables used. The third section demonstrates the analysis used in order for the purposes of explaining the bilateral trade. The final part is the actual conclusion. Literature Review The model is mostly used more often to empirically analyze trade between countries. It has been described as the workhorse of trade that involved different countries and its ability to correctly estimate bilateral trade flow. In the recent past years there has been abnormal change and progress both in improving its empirical estimation and understanding theoretical basis for the entire equation. The name gravity model comes from its use of gravitational force concept as a method of explaining the volume of bilateral trade flows. At first, it was only based on theoretical intuition, but later on, different theoretical foundation has been invented. Newtons law of gravity promoted the original gravity model of economic interaction over the space. The gravity model continues to be successful as it correctly predicts the actual trade flows between countries for different goods and services. It uses to estimate the pattern of international trade. The model basic form is made up of elements that are largely concerned of spatiality and geography, gravity model are mostly being used to check rooted on hypotheses purely in economic theories of trade. Such theories suggest that trade will be built on relatively factor abundances. Countries with plenty of one factor would then produce goods which requires relatively big amount of factors in their real production. The gravity model of trade has also been used in the area of international relations in order to determine the effect of treaties and alliances on trade activities. The model analyzes the effectiveness and efficiency of foreign trade agreements. (Prehn, Brmmer and Glauben 2016). Lately, gravity model mostly describe bilateral the flows of trade between different countries that cannot be explained by other economic theories. Factors such as infrastructure, exchange rates and income differences are included to the standard gravity equation, are found to be most significant determinant of bilateral trade flows (Nowak-Lehmann and Martinez-Zarzoso 2004). The Vietnam bilateral trade is mostly affected by economic size, openness and common language, GDP per capita, and negatively by the actual area between the trading partners. Model Description The model is mainly being use to ensure the smooth flows of trade between two countries that are unable to be solved via other economic theories. Based on the law of gravitation, the G between two matters remains proportional of their respective masses and universally connected to square of respective distance. The equation of the model is given as follows: Where; The gravity model can also be described by the equation below: The model was first applied by Timbergen to analyze foreign trade flows in the year 1962. In such a model, whereas trade flow between country A and B stood as the dependent variable, geographical distance and GDP remained the independent. Where this model is used, the eventual result indicates that as unlike distance, GDP variable shows a positive effect on trade flow between A and B. This implies that an economy with larger economic size as well as closer distance has a tendency of trading with one another more (Baier and Bergstrand 2009). The model has been used is the analysis of predicted trade flows alongside observing differences between predicted as well as observed flows (residual analysis). This is basically analysis of trade potentials of economies of transitions also called out-of sample predictions; identification of natural markets as well as markets with the untapped potentials of trade. It is also mainly used in the analysis of the predicted values utilized in some instances as the input for CGE modeling. Residual variance has been considered via the use of confidence intervals alongside predicted values. Analysis of result The diagnostic test is used to illustrate the assumption of random effects model. Final illustration states that there are heteroscedasticity and multicollinearity. Multicollinearity can be described by high association of Vietnams population and Vietnams GDP. If we employ the use of a large data in the study, then the actual effect of multicolinearity on the result can be controlled. The table below estimate results using the above equation of gravity model after resolving defects. The variables which has an effect on Vietnams bilateral trade are: foreign market size (Nj),distance(Dij), exchange rate(EXiJ), Economic size of both Vietnam and partner country(Yi,Yj) and culture(Cij). The growth of GDP of partners and Vietnam help in increasing the total trade value. An increase of 1% in foreign partners GDP will improve trade value by roughly 0.8% (Baltagi, Egger and Erhardt 2017). Conclusion The main purpose of the report is for the determination of factors that influence bilateral trade flows between partners countries and Vietnam around the world; and then establishing variables that is used. The model was estimated with data derived from different countries in the the year of 2015. The result obtained indicated that bilateral trade flows between partners countries and Vietnam are mostly affected by the foreign market size, geographical distance, national culture and economic size. The actual progress in foreign partners and the economic size of Vietnam has a good impact on the movement of bilateral trade. The limitation of the study is that it is only limited in the data when some areas has not been identify and included in the research. References Baier, S.L. and Bergstrand, J.H., 2009. Bonus vetus OLS: A simple method for approximating international trade-cost effects using the gravity equation.Journal of International Economics,77(1), pp.77-85. Baltagi, B.H., Egger, P.H. and Erhardt, K., 2017. The estimation of gravity models in international trade. InThe Econometrics of Multi-dimensional Panels(pp. 323-348). Springer, Cham. Bergstrand, J.H., 1985. The gravity equation in international trade: some microeconomic foundations and empirical evidence.The review of economics and statistics, pp.474-481. ekyay, B., Palut, P.T., Kabak, ., lengin, F., zayd?n, . and lengin, B., 2017. Analysis of the impact of bilateral and transit quotas on Turkey's international trade by road transport: An integrated maximum flow and gravity model approach.Research in Transportation Economics. Egger, P., 2002. An econometric view on the estimation of gravity models and the calculation of trade potentials.The World Economy,25(2), pp.297-312. Mansfield, E.D. and Reinhardt, E., 2015. 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